nep-cfn New Economics Papers
on Corporate Finance
Issue of 2005‒03‒06
nine papers chosen by
Zelia Serrasqueiro
Universidade da Beira Interior

  1. The commons with capital markets. By Rowat, Colin.
  2. Credit Risk, Credit Rationing, and the Role of Banks: The Case of Risk Averse Lenders By Thilo Pausch
  3. Shareholders Unanimity With Incomplete Markets By Daniele Coen-Pirani
  4. Close-form pricing of benchmark equity default swaps under the CEV assumption By Campi,Luciano; Sbuelz,Alessandro
  5. Assessing credit with equity : a CEV model with jump to default By Campi,Luciano; Polbennikov,Simon; Sbuelz,Alessandro
  6. On the Role of the Growth Optimal Portfolio in Finance By Eckhard Platen
  7. The value of tax shields is not equal to the present value of tax shields: A correction By Fernandez, Pablo
  8. Reply to "Comment on the value of tax shields is NOT equal to the present value of tax shields" By Fernandez, Pablo
  9. Pricing American Options on Jump-Diffusion Processes using Fourier Hermite Series Expansions By Carl Chiarella; Andrew Ziogas

  1. By: Rowat, Colin.
    Abstract: We explore commons problems when agents have access to capital markets. The commons has a high intrinsic rate of return but its fruits cannot be secured by individual agents. Resources transferred to the capital market earn lower returns, but are secure. In a two period model, we assess the consequences of market access for the commons' survival and welfare; we compare strategic and competitive equilibria. Market access generally speeds extinction, with negative welfare consequences. Against this, it allows intertemporal smoothing, a positive effect. In societies in which the former effect dominates, market liberalisation may be harmful. We reproduce the multiple equilibria found in other models of competitive agents; when agents are strategic, extinction dates are unique. Strategic agents generally earn their surplus by delaying the commons' extinction; in unusual cases, strategic agents behave as competitive ones even when their numbers are small.
    Keywords: commons, capital markets, Washington Consensus, property rights
    JEL: C73 D91 O17 Q21
    Date: 2004–12
  2. By: Thilo Pausch (University of Augsburg, Department of Economics)
    Abstract: The standard situation of ex post information asymmetry between borrowers and lenders is extended by risk aversion and heterogenous levels of reservation utility of lenders. In a situation of direct contracting optimal incentive compatible contracts are valuable for both, borrowers and lenders. However, there may appear credit rationing as a consequence of borrowers optimal decision making. Introducing a bank into the market increases total wealth due to the appearance of a portfolio effect in the sense of first order stochastic dominance. It can be shown that this effect may even reduce the problem of credit rationing provided it is sufficiently strong.
    Keywords: risk aversion, costly state verification, credit rationing, bank
    JEL: D82 G21 L22
    Date: 2005–02
  3. By: Daniele Coen-Pirani
    Abstract: Macroeconomic models with heterogeneous agents and incomplete markets (e.g. Krusell and Smith, 1998) usually assume that consumers, rather than firms, own and accumulate physical capital. This assumption, while convenient, is without loss of generality only if the asset market is complete. When financial markets are incomplete, shareholders will in general disagree on the optimal level of investment to be undertaken by the firm. This paper derives conditions under which shareholders unanimity obtains in equilibrium despite the incompleteness of the asset market. In the general equilibrium economy analyzed here consumers face idiosyncratic labor income risk and trade firms' shares in the stock market. A firm's shareholders decide how much of its earnings to invest in physical capital and how much to distribute as dividends. The return on a firm's capital investment is affected by an aggregate productivity shock. The paper contains two main results. First, if the production function exhibits constant returns to scale and short-sales constraints are not binding, then in a competitive equilibrium a firm's shareholders will unanimously agree on the optimal level of investment. Thus, the allocation of resources in this economy is the same as in an economy where consumers accumulate physical capital directly. Second, when short-sales constraints are binding, instead, the unanimity result breaks down. In this case, constrained shareholders prefer a higher level of investment than unconstrained ones.
  4. By: Campi,Luciano; Sbuelz,Alessandro (Tilburg University, Center for Economic Research)
    Abstract: Equity Default Swaps are new equity derivatives designed as a product for credit investors. Equipped with a novel pricing result, we provide closedform values that give an analytic contribution to the viability of cross-asset trading related to credit risk.
    JEL: G12 G33
    Date: 2005
  5. By: Campi,Luciano; Polbennikov,Simon; Sbuelz,Alessandro (Tilburg University, Center for Economic Research)
    Abstract: Unlike in structural and reduced-form models, we use equity as a liquid and observable primitive to analytically value corporate bonds and credit default swaps. Restrictive assumptions on the .rm.s capital structure are avoided. Default is parsimoniously represented by equity value hitting the zero barrier either di¤usively or with a jump, which implies non-zero credit spreads for short maturities. Easy cross-asset hedging is enabled. By means of a tersely speci.ed pricing kernel, we also make analytic credit-risk management possible under systematic jump-to-default risk.
    JEL: G12 G33
    Date: 2005
  6. By: Eckhard Platen (School of Finance and Economics, University of Technology, Sydney)
    Abstract: The paper discusses various roles that the growth optimal portfolio (GOP) plays in finance. For the case of a continuous market we showhow the GOP can be interpreted as a fundamental building block in financial market modeling, portfolio optimization, contingent claim pricing and risk measurement. On the basis of a portfolio selection theorem, optimal portfolios are derived. These allocate funds into the GOP and the savings account. A risk aversion coe±cient is introduced, controlling the amount invested in the savings account, which allows to characterize portfolio strategies that maximize expected utilities. Natural conditions are formulated under which the GOP appears as the market portfolio. A derivation of the intertemporal capital asset pricing model is given without relying on Markovianity, equilibrium arguments or utility functions. Fair contingent claim pricing, with the GOP as numeraire portfolio, is shown to generalize risk neutral and actuarial pricing. Finally, the GOP is described in various ways as the best performing portfolio.
    Keywords: growth optimal portfolio; portfolio optimization; market portfolio; fair pricing; risk aversion coefficient
    JEL: G10 G13
    Date: 2005–01–01
  7. By: Fernandez, Pablo (IESE Business School)
    Abstract: I correct some expressions in Fernández (2004) and provide a more general expression for the value of tax shields. This expression is the difference between the present values of two different cash flows, each with its own risk: the present value of taxes for the unlevered company and the present value of taxes for the levered company. The value of tax shields in a world with no leverage cost is the tax rate times the current debt, plus the tax rate times the present value of the net increases of debt. The value of tax shields depends only on the nature of the stochastic process of the net increase of debt; it does not depend on the nature of the stochastic process of the free cash flow.
    Keywords: Value of tax shields; present value of the net increases of debt; required return to equity;
    JEL: G12 G31 G32
    Date: 2005–02–14
  8. By: Fernandez, Pablo (IESE Business School)
    Abstract: The Comment is thought provoking and helps a lot in rethinking the value of tax shields. However, the conclusion of Fieten, Kruschwitz, Laitenberger, Löffler, Tham, Vélez-Pareja and Wonder (2005) is not correct because, as will be proven below, the main result of Fernández (2004) is correct for several situations. Equation (16a) shows that the value of tax shields depends only upon the nature of the stochastic process of the net increase of debt.
    Keywords: Value of tax shields; present value of the net increases of debt;
    JEL: G12 G31 G32
    Date: 2005–01–15
  9. By: Carl Chiarella (School of Finance and Economics, University of Technology, Sydney); Andrew Ziogas (School of Finance and Economics, University of Technology, Sydney)
    Abstract: This paper presents a numerical method for pricing American call options where the underlying asset price follows a jump-diffusion process. The method is based on the Fourier-Hermite series expansions of Chiarella, El-Hassan & Kucera (1999), which we extend to allow for Poisson jumps, in the case where the jump sizes are log-normally distributed. The series approximation is applied to both European and American call options, and algorithms are presented for calculating the option price in each case. Since the series expansions only require discretisation in time to be implemented, the resulting price approximations require no asset price interpolation, and for certain maturities are demonstrated to produce both accurate and efficient solutions when compared with alternative methods, such as numerical integration, the method of lines and finite difference schemes.
    Keywords: American options; jump-diusion; Fourier-Hermite series expansions; free boundary problem
    JEL: C61 D11
    Date: 2005–01–01

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